Kuish v. Smith (2010): When a Nonrefundable Deposit Must Be Returned in California

A Nine-Month Escrow on the Sand

In December 2005, Bradford Kuish offered to buy William and Rhonda Smith's single-family home in Laguna Beach. After an offer and nine counteroffers, the parties signed a purchase agreement on January 7, 2006, at a price of $14 million.

The agreement required two "non-refundable" deposits of $400,000 each. The first was to be released to the sellers once contingencies were approved. Escrow was set to close by July 28. Through later escrow instructions, the parties changed the deposit schedule twice and moved the closing date twice, ending with a total deposit of $620,000 and a September 15, 2006 closing. Of that amount, $400,000 was released to the sellers and $220,000 stayed in escrow.

On September 18, the buyer's lawyer asked the escrow company to cancel. The parties signed cancellation instructions on October 17. The sellers turned to a backup offer and closed a sale to that buyer for $15 million on November 16. The parties stipulated that the home was worth $15 million when the buyer cancelled.

The sellers refused to return any of the money and would not let escrow release the $220,000 it still held. The only damage they identified was $9,483.15 for harm to the roof during the buyer's staking of the property.

The Trial Court: Sophisticated Parties, Separate Consideration

After a bench trial, the Orange County Superior Court ruled for the sellers. It found that $20,000 of the deposit was refundable but offset it entirely with the roof damage and interest. It held that keeping the remaining $600,000 was not a forfeiture because both sides were sophisticated businesspeople who freely negotiated the deposit terms, and it called the deposit separate consideration for the sellers' agreement to keep escrow open for nine months.

The trial court also emphasized that this was not an ordinary house purchase. The buyer planned major renovations requiring approvals from several agencies, which naturally took time.

"Any provision by which money or property would be forfeited without regard to the actual damage suffered would be an unenforceable penalty."

Freedman v. The Rector (1951), quoted in Kuish v. Smith (2010)

Why the Court of Appeal Reversed

In a rising market, the seller's damages were close to zero

California measures a seller's damages when a buyer breaches a purchase contract under Civil Code section 3307: the amount by which the contract price exceeds the property's value, plus consequential damages and interest. The Smiths resold for $1 million more than Kuish had agreed to pay. Apart from the roof, they did not claim any actual damages.

Freedman v. The Rector controls deposits kept as a penalty

The court relied on the California Supreme Court's decision in Freedman v. The Rector (1951) 37 Cal.2d 16. There, a buyer who repudiated a land purchase was held entitled to recover his down payment, less what the seller actually lost, because the seller resold for $2,000 more. The Supreme Court held that even a buyer whose breach is willful can recover the part of the payment that exceeds the seller's actual damage. Letting the seller keep more would be a penalty, and California law disfavors penalties and forfeitures in contract cases.

Calling a deposit "non-refundable" does not make it liquidated damages

The court reasoned that reading "non-refundable" to let the sellers keep the whole deposit regardless of actual damages would, in effect, create a liquidated damages clause. The parties had stipulated their contract had none. And even if the term were treated as one, it would fail Civil Code section 1677, which makes a seller's liquidated damages provision invalid unless each party separately signs or initials it, and, in a printed contract, it appears in at least 10-point bold type or 8-point bold red type.

The court noted the deposit would have been nonrefundable in a falling market to the extent the sellers could prove damages under section 3307. The deposit works as a fund the seller can draw on for real losses, and it puts the burden on the buyer to show that keeping it would be unjust enrichment.

The deposit was not payment for extending escrow

The sellers relied on Horowitz v. Noble (1978) 79 Cal.App.3d 120, where sophisticated developers agreed in a later, separate agreement that $20,000 would be "irrevocably disbursed" in exchange for extending the closing date. The Kuish court distinguished it. Here, none of the amended escrow instructions that extended closing said the deposit was nonrefundable or irrevocably released. The "non-refundable" language was in the original contract, so it could not be new consideration for later changes. Accepting the sellers' argument, the court said, would create an exception that swallows the Freedman rule.

When Can a Seller Keep the Buyer's Deposit in California?

Short answerA California seller can keep a buyer's deposit after the buyer defaults if the contract has a valid liquidated damages clause, separately initialed by both parties. For an owner-occupied home of one to four units, an amount up to 3 percent of the price is presumed valid. Without a valid clause, the seller may keep only what it can prove it actually lost.

How California's 3 Percent Rule Works

For most home purchases, the deposit fight turns on Civil Code section 1675. It applies to "residential property": a dwelling of no more than four units that the buyer intends, when the contract is made, to occupy as a residence.

• Only money actually paid countsThe clause is valid only to the extent payment in cash or by check, including a postdated check, was actually made.
• 3 percent or less is presumed validThe buyer must prove the amount is unreasonable as liquidated damages to get it back.
• More than 3 percent is presumed invalidThe seller must prove the amount is reasonable to keep it.
• Later resales matterReasonableness is judged by the circumstances when the contract was made and by the terms of any resale made within six months of the buyer's default. A resale at a higher price, as in Kuish, cuts against the seller.
• Each payment needs its own initialsIf more than one payment is to count as liquidated damages, Civil Code section 1678 requires a separate initialed clause for each later payment.

Commercial property, investment property, and homes the buyer does not intend to live in fall outside section 1675. For those, liquidated damages clauses are tested under the general rule in Civil Code section 1671, but section 1677's initialing and type-size requirements still apply to any real property purchase contract.

Getting a Deposit Released From Escrow

Escrow companies will not release a disputed deposit without matching instructions from both sides. For owner-occupied homes of one to four units, Civil Code section 1057.3 adds a penalty for refusing to sign without a good reason.

• 30 days after a written demandA buyer or seller who does not sign the release documents within 30 days after a written demand can be liable for the deposit, plus treble damages of at least $100 and at most $1,000, plus reasonable attorney's fees.
• Good faith disputes are excusedNo penalty applies if the funds are held to resolve a good faith dispute, meaning the withholding party reasonably believed it was entitled to the money.
• Signing a release does not end the contractUnless cancellation is stated, signing escrow release paperwork does not by itself cancel the purchase contract or waive a breach of contract claim.

Deposit disputes in Glendale and Los Angeles transactions that cannot be resolved by agreement are filed in the Los Angeles County Superior Court. Many standard California purchase agreements include a mediation clause, so real estate mediation is often the first formal step.

What Buyers and Sellers Should Do

1. Read the deposit and liquidated damages terms before signing

   Check whether a liquidated damages clause exists, whether both parties initialed it, and how much of the deposit it covers. A "non-refundable" label is not the same thing.

2. Track every contingency deadline

   Most deposit disputes start with a missed deadline. A cancellation inside a contingency period usually protects the buyer; a cancellation after removal usually does not.

3. Be careful with early release of deposit funds

   Money released to the seller during escrow, as $400,000 was in Kuish, can be harder to recover even if the law is on the buyer's side.

4. If you are the seller, document your losses

   Without a valid clause, a seller keeps only proven damages. Keep records of carrying costs, a lower resale price, and other consequential costs.

5. Send a written demand

   A written demand for release of escrow funds starts the 30-day period under Civil Code section 1057.3 and creates a clear record.

6. Get advice before the deal collapses

   A short review of the contract and the facts can show whether to cancel, extend, renegotiate, or insist on closing. The firm's real estate transaction practice handles these reviews.

How DiJulio Law Group Approaches Deposit and Escrow Disputes

Deposit cases are decided on the contract language, the escrow instructions, the timeline, and the numbers: the contract price, the resale price, and the costs each side can prove. The firm starts by putting those in order, then decides whether a demand letter, mediation, or litigation is the right next step. When the seller is the one walking away, the analysis turns to specific performance and, where appropriate, recording a lis pendens, discussed in the firm's analysis of Kirkeby v. Superior Court.

The firm represents buyers and sellers in Glendale, Los Angeles, and throughout Southern California through its California real estate law practice, with trial and appellate work handled by Valeria Granata.